Dissolution and the Insolvent Partner: Applying Garner v. Murray
P, Q and R carried on business sharing profits 2:2:1. Their balance sheet on 31 March 2024 showed capitals of ₹2,00,000, ₹1,00,000 and ₹20,000; creditors ₹1,00,000; P's loan ₹50,000; bank loan ₹50,000; and assets comprising machinery ₹2,50,000, stock ₹1,20,000, debtors ₹1,00,000, investments ₹40,000 and cash ₹10,000. The firm was dissolved on 1 April 2024. Machinery realised ₹1,60,000, stock ₹80,000, debtors ₹85,000 and investments ₹40,000. Realisation expenses were ₹15,000, paid by Q from her personal bank account. Creditors were paid in full and the bank loan, secured on machinery, was repaid. P's loan was also repaid. R's private estate realised nothing and he was declared insolvent. P argues that R's deficiency must be shared in the profit-sharing ratio 2:2:1, while Q argues that P's loan should be treated as capital so that P bears a larger share of the loss.
1. Compute R's deficiency and show how it is borne, citing the rule.
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Loss on realisation = book value of assets realised ₹5,10,000 + expenses ₹15,000 − proceeds ₹3,65,000 = ₹1,60,000. Shared 2:2:1: P ₹64,000; Q ₹64,000; R ₹32,000.
R's capital is ₹20,000 − ₹32,000 = (₹12,000). Since R's estate pays nothing, ₹12,000 is an irrecoverable deficiency.
Under Garner v. Murray, the deficiency of an insolvent partner is borne by the solvent partners in the ratio of their capitals as at the date of dissolution, not in the profit-sharing ratio. Capitals: P ₹2,00,000 and Q ₹1,00,000, i.e. 2:1. P bears ₹8,000 and Q bears ₹4,000.
2. Prepare the Realization Account and the Partners' Capital Accounts.
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Realization Account
| Particulars | ₹ | Particulars | ₹ |
|---|---|---|---|
| To Machinery | 2,50,000 | By Bank - machinery | 1,60,000 |
| To Stock | 1,20,000 | By Bank - stock | 80,000 |
| To Debtors | 1,00,000 | By Bank - debtors | 85,000 |
| To Investments | 40,000 | By Bank - investments | 40,000 |
| To Bank - expenses | 15,000 | By Loss on realisation | 1,60,000 |
| Total | 5,25,000 | Total | 5,25,000 |
Liabilities are paid separately: creditors ₹1,00,000; bank loan ₹50,000; P's loan ₹50,000.
Capital Accounts: P = 2,00,000 − 64,000 − 8,000 = ₹1,28,000; Q = 1,00,000 + 15,000 (expenses paid) − 64,000 − 4,000 = ₹47,000; R = 20,000 − 32,000 = nil after writing off the deficiency. Cash available: 10,000 + 3,65,000 − 1,00,000 − 50,000 − 50,000 = ₹1,75,000, equal to P ₹1,28,000 + Q ₹47,000.
3. Evaluate P's and Q's arguments.
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P's argument is wrong: Garner v. Murray uses the capital ratio, not the profit-sharing ratio, for an insolvent partner's deficiency. Q's argument is also wrong: P's loan is a debt of the firm to a partner, payable before capital, and is not treated as capital for deficiency. If the loan were treated as capital, P's capital ratio would change and Q would bear more, but that would rewrite the legal character of the loan. The loan was repaid in full, and P's capital alone bears the deficiency share. The result would differ only if the deed said otherwise, or if the loan were really disguised capital - not the case here.